The Importance Of Zero In Destroying The Scarcity Myth Of Economics

from the let's-go-back-to-basic-math dept

A couple weeks ago, I wrote about all the well-deserved attention being placed on the idea of the economics of abundance. The discussion around that topic, both in the comments and in a series of emails has been quite interesting. Not everyone agrees with the concept, and that presents something of a challenge. It always interests me to figure out what the points of disagreement are in various intellectual debates. Larry Lessig recently quoted Al Gore in talking about the importance of "removing blocks." Basically, the idea is that, when people disagree with you, look closely at the points on which they disagree, and try to figure out why that disagreement is occurring. You can often learn some very interesting things, while challenging your own opinion on things. I am planning a series of posts on this topic, to see if we might be able to clear out the blocks concerning the economics of digital content. To start it off, I'm going to recap the talk (and the reasoning behind it) I gave back in April.

When Jim Harper of the Cato Institute kindly invited me to be on a panel discussion about copyrights at Cato in their Washington DC office, I had a lot of trouble figuring out what I was going to talk about. I had been spending a lot of time trying to understand why there was such a split among folks who prided themselves on having a "free market" or libertarian view of the world -- but who seemed to completely disagree on the economics of content. It bothered me that people who started with the same fundamental toolbox ("the free market is good") would end up at such widely divergent views. On the one side were folks like the Progress & Freedom Foundation, who felt that strong intellectual property laws (including things like stronger protections of DRM) were necessary to build an economy around content. On the other, were folks like myself, Tim Lee and David Levine, who saw that these intellectual property laws were basically government granted monopolies that could hold back economic progress.

As I mentioned in my recap to the panel discussion, I had my "Eureka!" moment on the airplane to DC. While I'd been reading through a bunch of text books on the economics of intellectual property, the history of intellectual property and the history of economics -- none seemed to answer the question of where the breakdown occurred. So I gave it all up, and decided to reread a book I'd picked up at a used book sale a few years back, called "Zero: The Biography of a Dangerous Idea" which is a fascinating history of the number zero -- and the fact that not only did it take societies ages to even recognize the number zero, it was considered heretical in some areas for a while. Zero caused all sorts of problems in that it didn't work like other numbers. It isn't a number. It's the absence of a number, and that screws up a lot of things. For thousands of years, it held back progress. You can't have advanced math or physics without an understanding of zero -- and the difficulty in accepting it was a real problem.

Of course, for all of us who learned about zero in elementary school, this seems laughable. How could zero be such a difficult concept to understand? Except, as I read the book, it occurred to me that it's the exact same problem that was causing this breakdown in the discussion. It's incredibly easy to misunderstand zero in economics. That's because economics, we're often taught, is the "science of scarcity" or understanding resource allocation in the presence of scarcity. All too often, economics itself is defined by scarcity. The "zero" changes all of that. Plugging a zero into an equation that expects a non-zero sends it haywire (think of what happens when you divide by zero) -- and that leads people to think that the equation must be broken. So, for example, basic economics tells you that a free market will push prices towards their marginal costs. If their marginal costs are zero (as is the case with digital goods and intellectual property), then it says that price will get pushed towards zero. However, this makes people upset, and makes them suggest the model is broken when a zero is applied. They see a result where there is no scarcity, and it doesn't make sense to them since they've always understood economics in the context of scarcity.

However, the point is that if you understand the zero, there's nothing to worry about and the model works perfectly. It just requires a recognition that the scarcity doesn't exist. Instead, you have abundance. You can have as much content as you need -- and in that world, it makes perfect sense that there's no costs, because without scarcity there need not be a cost. Supply is infinite, and price is zero. That does not mean, however, that there's no business. Instead, it just means you need to flip the equation and use the zero to your advantage. Instead of thinking of it as forcing a "price" of zero, you think of it as being a "cost" of zero. Suddenly, you've lowered the cost of making something to nothing -- and you should then try to use as much of it as you can. One simple example of this is to use that item that "costs" zero as a promotional good for something that does not have a zero marginal cost. When you realize how zero factors in, you realize that there's nothing new or radical here at all. It's just coming to terms with the idea that free market economics still works in the face of zero (in fact, it thrives) and there's no reason to put in place government-sanctioned barriers to shape the market.

scarcity

If you are right that there is a viable business in DRM-free distribution of content, what difference does it make whether the government has "strong intellectual property laws"? Even with such laws, owners of intellectual property are free to license use of their property on whatever terms they find favorable. If you're right, why won't they simply provide a blanket license to all users to take advantage of the economics of abundance (effectively opting out of whatever intellectual property protection the government would otherwise provide)?

Re: scarcity

Even with such laws, owners of intellectual property are free to license use of their property on whatever terms they find favorable.

Unfortunately, it's not that easy. With changes to copyright law, you automatically get a copyright on any material. It's only recently, with things like Creative Commons that it's been easier to do things like distribute your content for free without copyright issues getting in the way.

So, I do agree that there is some stuff that can be done within today's IP environment -- and I absolutely encourage companies and content creators to look for ways to leverage that.

However, some areas of IP rules are much worse -- such as proposals to *require* DRM in new consumer electronics, or banning anti-circumvention techniques that can cause lots of problems for perfectly legitimate uses.

So, yes, a first step is to get content owners to recognize this -- and then the legal changes will be much easier. But that doesn't mean that current laws don't contribute to additional problems.

Re: Re: scarcity

Even with such laws, owners of intellectual property are free to license use of their property on whatever terms they find favorable.

Mike replied

Unfortunately, it's not that easy. With changes to copyright law, you automatically get a copyright on any material.

Henry was right.

Look at the growth of free ware and open source software. All of that software is protected by copyright but the creators can declare that the whole world has a licence to use it.

People who create copy righted material - be it music books or movies have the right to set the terms on which they are prepared to sell it. The music industry and the movie industry are grossly overreaching in their efforts to enforce those rights but that does not change the fact that they have those rights.

If Mike was right then there would have been a "free" Internet based music industry by now and there isn't.

None of this applies to patents which pose a completely different set of problems.

Re: Re: Re: scarcity

I am really lost. How would automatic copyrights make it harder to freely license your ideas? And why would mike saying it is harder imply that he has falsely predicted a free internet based music industry? What does that have to do with it? If anything it predicts the opposite. If somehow it is harder to freely license your ideas..then..it would be..harder to give them away for free?

Re: Re: Re: scarcity

Look at the growth of free ware and open source software. All of that software is protected by copyright but the creators can declare that the whole world has a licence to use it.

Yes, that's true with some content, but it's not so easy with other types of content.

People who create copy righted material - be it music books or movies have the right to set the terms on which they are prepared to sell it. The music industry and the movie industry are grossly overreaching in their efforts to enforce those rights but that does not change the fact that they have those rights.

Yup. No argument from me there. They do have those rights, but part of the point is that it's dangerous for them to keep enforcing them.

If Mike was right then there would have been a "free" Internet based music industry by now and there isn't.

No, that's not true at all. The point is that is where the market is headed, but the time frame need not be immediate. I still believe there absolutely will be a free internet-based music industry (and some are already doing well by embracing that concept), but old habits and business models die hard, so it takes time.

Re: scarcity

Actually, there are a few content distributors who do as Mike suggests. They are making money at it.

If you want to see a real world example, go over to Baen Books at Baen.com. The publisheer, and many of the authors he publishes, give away electronic copies of books. They have found it sells many more books.

Jim Baen started after a discussion where another publisher wanted to abolish public libraries to prevent people from reading a book without paying for it. (Piracy is rampant in libraries apparently.) Mr. Baen expressed a view that libraries actually increase sales of books by providing exposure to authors. When challenged, he decided to put his money where his mouth is. The idea worked.

He is still trying to find ways to expand on it. Read the essays he has. Not a lot of economic theory, but lots of real world examples that it works. And not just for music.

Mike seems to be right here. Incidently, after reading one or two books on the computer, I went out and bought a couple of the authors books I had read. Seems Mikes ideas worked on me too.

One interesting tidbit. Mr. Baen was told that a cd with over 50 of his books was being sold on E-Bay. His response was that the fool who bought it (at around $100.00) could have gotten it from the publisher for less than $25, included in the back of a hardcover book. The lawyer who told him about it went away dissapointed. No lawsuit.

Re: missing something

Mike specifically describes the marginal cost as being zero - that is, the cost of reproduction. The business you are now in is no longer publication (since the marginal cost for everyone is zero, and the cost of entry into the publication market is also zero, there's zero income to be made from publication), but production.

So there you are, it costs money to produce some content, but publication is absolutely zero cost (but also zero income). What do you do? You shift your market focus from publication to production. Get people to pay you for the production of content, rather than the publication of the content.

In the music industry, who produces the content? The artist, the songwriter, the lyric writer. How do they get to charge for production? Sell tickets to concerts. The song/lyric writer might get some extra income producing works for hire.

What happens to the recording studio? They get paid by the artist to produce albums, and that's the end of their involvement.

What happens to the recording industry executive? Their market (selling other peoples' work) has dried up. Either they get into the business of concert promotion, or they hand back the keys for their lease-hire BMW.

False lack of scarcity

There is no question that the efficient market has constant pressure to drive prices to the incremental costs of production. However, stating that the market price should equal to the incremental costs (in this case, effectively zero) is disingenuous and short-sighted. For many types of IP, the fixed costs are astronomical and the incidence of any return on investment very low.

Music and drugs are classic examples of this: the lion's share of the cost is in producing the first cut of the album, or getting the first pill onto the store shelves. After that, it's basically free to make and distribute more of the same. And that's the key: it's free to create more of the same. Without a market way to recoup the fixed costs, there is no incentive for capital holders to invest in new developments. They'll instead put their money into new housing developments with a good ROI, and the private funding of new innovation in music and drugs will fall to zero, unless propped up by the state.

One of the reasons America has been so successful is that we've created an environment where there is money to be made in the sectors that benefit society: technological innovation, creation of cultural works, process improvements to reduce the cost of consumer goods. This creates constant positive incentive to invest more money in those areas, and society as a whole benefits. Innovation is inherently Intellectual. Without giving it the kind of protection that we have in good IP laws, any innovation created by a well-capitalized endeavor can immediately be copied by the "generics", and the well of capital will move to tangible items (please do note the distinction between "good IP laws" and just plain "IP laws").

Scarcity will always be at the heart of economics. With the advent of digital media and digital duplication, the incremental cost per unit has ceased to overwhelm the scarcity equation. Now the scarcity is primarily in the time of the content creators and, by extension, the capital to pay them while they work. There is no embarassment of plenty; I still don't have enough time to create all of the freely-distributed works that I want.

Re: False lack of scarcity

Music and drugs are classic examples of this: the lion's share of the cost is in producing the first cut of the album, or getting the first pill onto the store shelves.

Yes, and that's a fixed, not marginal cost.

After that, it's basically free to make and distribute more of the same. And that's the key: it's free to create more of the same. Without a market way to recoup the fixed costs, there is no incentive for capital holders to invest in new developments.

The point is that there absolutely still are ways to make money -- in fact even more money.

They'll instead put their money into new housing developments with a good ROI, and the private funding of new innovation in music and drugs will fall to zero, unless propped up by the state

This is provably false -- especially in the pharma industry. Specifically many countries did not allow patenting of pharmaceuticals until very recently. Look at the history of the Italian pharma market, for example. Until 1978, you couldn't get patents on pharma, but the industry was thriving, one of the largest in the world. After the law changed to allow patents, the industry pretty much dried up in Italy, and the amount of research and development in the space went away.

Without giving it the kind of protection that we have in good IP laws, any innovation created by a well-capitalized endeavor can immediately be copied by the "generics", and the well of capital will move to tangible items (please do note the distinction between "good IP laws" and just plain "IP laws").

You are giving the IP laws way too much credit. And, you make the very false assumption that "generics" immediately replace the market for originals. You also leave out the side effects of using these things as promotional materials that allow for much bigger markets where even more money is available.

Scarcity will always be at the heart of economics. With the advent of digital media and digital duplication, the incremental cost per unit has ceased to overwhelm the scarcity equation.

Scarcity is always at the heart of selling -- not necessarily of economics.

Now the scarcity is primarily in the time of the content creators and, by extension, the capital to pay them while they work.

That's a fixed cost.

There is no embarassment of plenty; I still don't have enough time to create all of the freely-distributed works that I want.

EXACTLY! But, that's a good thing. There's money to made in paying people to create new works of content. That's got value, because that is scarce. But the point is once the content is created, it's abundant and will be priced accordingly.

Re: Re: False lack of scarcity

This is a fascinating topic.

That's a fixed cost.

You keep discounting the fixed costs when looking at the economics of abundance. To recoup the investment in innovation, you need to recoup [(fixed costs/# of units) + maginal costs] per unit. Historically the marginal costs have overwhelmed the amortized fixed costs in economies of scale, but when marginal costs approach zero, the required price to continue to stay in business (and producing new innovation) is only the amortized fixed cost.

When discussing an economy of abundance, you need to either recoup the majority of the fixed cost out-of-band or base the price of the product on the amortized fixed cost. If there's no positive cash flow, there's no capitalized innovation. That's true in Italy, and it's true here. You do a good job of reporting on innovations in offsetting the fixed costs, but in the end, you have to bring in more money than you spend.

With regard to the Italian pharma industry pre-1978, I assume you're referring to the Boldrin/Levine "Against Intellectual Monopoly" paper (correct me if I'm wrong). I'm a bit skeptical in a "great claims require great evidence" kind of way; they compare a 20 year sample from a single country to a 3 year sample skewed by 60% in time from the inception of patents there. Throughout most of the rest of the paper, they're recounting how robust the production of goods is, rather than the rate of innovation. It's not shocking to see that if the capitalized industry continues to produce new IP (e.g. the music industry) and markets exist where it has no protection (e.g. Napster), the rate of "generics" production will suddenly skyrocket. I'm still reading the paper, but the level of linguistic rigor leaves me feeling a bit skeptical of its academic rigor; are you aware of any peer reviews of that work?

There's money to made in paying people to create new works of content. That's got value, because that is scarce.

The hard part is finding ways to recoup my investment in paying people to create the new works of content. Open Source software is, of course, the perfect example of many of the factors of the abundance issue. The corpses of Bubble companies prove how hard it is to create a successful business when you don't recoup your costs directly from unit prices. Red Hat and a very few other vendors have made a good go of it, but the success rate is far below that of more conventional businesses.

I'm looking forward to a world where my grand-children wonder how people ever got away with charging for information. I'm not sure, though, that any system that forces the issue by drastically weakening IP will continue to be innovative enough to stay at the head of the pack.

Re: Re: Re: False lack of scarcity

You keep discounting the fixed costs when looking at the economics of abundance. To recoup the investment in innovation, you need to recoup [(fixed costs/# of units) + maginal costs] per unit. Historically the marginal costs have overwhelmed the amortized fixed costs in economies of scale, but when marginal costs approach zero, the required price to continue to stay in business (and producing new innovation) is only the amortized fixed cost.

You're right... I don't mean to be "discounting" the fixed costs, but it comes out that way. I'm discounting the fixed costs once the content has been created. That's a sunk cost and we all know sunk costs are meaningless towards future pricing.

But, you're right that fixed costs matter very much in making the build/don't build decision. Which is where I fall back to the point that before an investment is made, the product is scarce and can be sold. In other words, you can convince someone (or a group of people) to pay for the fixed cost, if there's enough benefit for them to have the product made. I gave the example with music, where you get enough people who are fans to pay for the production of the next album -- providing a combination of incentives.

With regard to the Italian pharma industry pre-1978, I assume you're referring to the Boldrin/Levine "Against Intellectual Monopoly" paper (correct me if I'm wrong). I'm a bit skeptical in a "great claims require great evidence" kind of way; they compare a 20 year sample from a single country to a 3 year sample skewed by 60% in time from the inception of patents there.

Yes, I was mostly referring to the Levine paper (entirely when it comes to the pharma example discussed) and you are right that it would be good to get more data on that. But it is a single example. I'm not as worried about the comparison between pre- and post- patent there. That's less important than the simple fact that pre-patent, there was a thriving industry. It seems like pretty good proof against the argument people make that without patents, there would be no pharma industry. That's provably false.

The funny thing about the market is that, when there's a real need for something, the market often comes up with very creative ways to make it worthwhile to produce without government help.

The hard part is finding ways to recoup my investment in paying people to create the new works of content. Open Source software is, of course, the perfect example of many of the factors of the abundance issue. The corpses of Bubble companies prove how hard it is to create a successful business when you don't recoup your costs directly from unit prices. Red Hat and a very few other vendors have made a good go of it, but the success rate is far below that of more conventional businesses.

I think this isn't the greatest example (and also suffers from a small sample size problem). There were numerous other issues that contributed to bubble-era problems, and I'm not sure you can really make the claim that businesses dealing in open source have been unsucessful. What's happened, instead, is that plenty of businesses now use, rely on *and* contribute to open source development -- not as their core business -- but because they recognize it's a resource that helps expand their core business.

I think that, really, is the key.

I'm looking forward to a world where my grand-children wonder how people ever got away with charging for information. I'm not sure, though, that any system that forces the issue by drastically weakening IP will continue to be innovative enough to stay at the head of the pack.

Again, I don't think you need to drastically weaken IP. I think you just need to recognize the inevitability of the situation, watch the companies that embrace it, and others will eventually have to follow. Economics solves the problem much faster than any policy change. However, I do worry about IP laws that make it more difficult for these changes to happen.

Re: Re: Re: Re: False lack of scarcity

I'm not as worried about the comparison between pre- and post- patent there. That's less important than the simple fact that pre-patent, there was a thriving industry. It seems like pretty good proof against the argument people make that without patents, there would be no pharma industry. That's provably false.

But a Pharmaceutical industry does not make your point - it must be an innovative market that produces new drugs for it to be a valid example - and you just dismissed the fact that it wasn't. Of course someone was producing drugs that were researched and protected elsewhere - at near marginal cost, because they are essentially generic drug makers. But to move the world market to that point, you would need some other incentive.

I think (and I'm not an economist) that the drug market is one where patents are less useful than simply allowing the information on a drug not to be published - that way, the drug can be tested, but not reproduced against the will of the creator. The FDA would still mandate a significant amount of the testing they currently do, if they want, but if a competitor wants to market the same drug, they could, but they will have to show that it is similarly safe (a 4-5 year process currently,) since they can't just claim it is the same drug.

Of course, this would allow perpetual safe keeping of the drug formula, but that's what the market would prefer anyways, and if the market is really lucrative, others will join - and since the approval process is several years, there is an effective protected period for the drug. Of course I might be missing something here, so anyone should feel free to correct me.

Re: Re: Re: Re: Re: False lack of scarcity

I think that's a great idea. Abolish drug patents and allow (not require) drug makers to keep their formulas secret. Then watch some companies keep them a secret, and others openly publish their formulas and compete via continuous innovation instead of secrecy. Which drug do you think the American public would feel better about taking? Aprozan - "trust us, the government says it's safe", or Dipelizor - "here's what's in it, feel free to research it yourself"? It's becoming apparent the FDA has been or is being co-opted by the drug industry. With several high-profile regulatory failures recently, I don't think secret drugs approved by the FDA are going to cut it.

US success

The reason the US has been so successful is that it inherited British industrialism, didn't have all its infrastructure or military blown to bits in the second world war and has been reaping the globes resources ever since - the ingenuity of a robber barron on a grand scale.

The current hysterical assault on industries that deal in intellectual property, primarily pharmaceuticals and entertainment, seems utterly baffling. These industries spew out extraordinary floods of worthy things: life-saving, life-enhancing drugs; breathtaking movies; music for every possible taste. And both are bitterly demonized, as if they cheat us by asking that money be paid in return for their wares.

Much of the demonization comes from the left, particularly academia, powered by intellectuals' habitual disdain for the market and lust for a government run by themselves. But disaffected intellectuals are always with us, and the deeper problem is that this disdain has found a lever to wield that has been created by the real culprits -- the economics profession.

This lever is a syllogism that I have now heard to the screaming point: It starts with the proposition, "Economics teaches us that in a competitive market prices equal marginal cost -- the extra costs incurred by producing an additional unit." It goes on to note that the marginal cost of an additional pill, or an additional copy of a movie or song, is close to zero. Therefore, the argument concludes triumphantly, "economics teaches us" that such products should be priced at zero. Any other condition demonstrates that undue "market power" exists, and is immoral. If one demurs to the logic, on the ground that it costs about $800 million dollars to produce the first pill, or $100 million to produce the first print of the movie and this initial investment -- not just the marginal cost of the second pill or the second print -- must be recovered from somewhere, the perpetrators of this logic usually shrug and talk about the need for new business models.

If you doubt the power of the "price should equal marginal cost" mantra, or the moral component that has been infused into it, check out speeches by officials of the Antitrust Division, such as William Kolasky, former Deputy

AG: "An economist would say that a market is perfectly competitive when firms price their output at marginal cost." Or a statement by Lawrence Summers, former Secretary of the Treasury and current President of Harvard: "[T]he most basic condition for economic efficiency [is] that price equal marginal cost." Or go look at almost any textbook, complete with diagrams.

To be fair to these two gentlemen, they immediately move on to note that of course this principle creates problems in an investment-intensive context because it does not allow for the recovery of capital cost. They have no answer for this dilemma, however, and they leave an impression that such situations are aberrational, perhaps temporary, and not a real issue, though Summers notes that this segment of the economy is growing.

The net result is to leave two misconceptions to run amok. First, that the fundamental theorem has any meaningful application outside of the classroom, and, second, that investment-heavy industries are exceptional cases when in fact they constitute almost the entire economy.

In explaining these misconceptions, it is helpful to focus on specific situations. Suppose I have a widget factory, routinely selling my widgets for $100 each. Someone comes to my factory and says "I'll give you $10 if you add one more widget to today's production run for me." I calculate that it would cost $9 in materials and labor to make the widget. Economic theory teaches that, judging solely by the optimal use of resources at that frozen moment of time, I should make the deal. If I do not, then welfare will be reduced because the buyer will not receive his utility, and the resources will either go unused or be put to an inferior use.

But this really says nothing about the price of widgets generally. Does it mean all my other widgets should have been sold for $10? No -- when I was thinking of investing in a widget factory my marginal cost calculation had to encompass the investment cost, so it was then nearer $100, not $9, whereas the theorem refers only to this precise day, even this hour. Does today's marginal cost say anything about my future prices? Not really; I need to recapture depreciation and interest, so $9 will not be enough.

So should I make the deal? Maybe. It depends on the overall effect on my business. Will my other customers find out? Will this guy pay the regular price if I refuse? How much will the competition charge? Will I lose good will from others? Do I save transaction costs by refusing to bargain, so that a special price cut will cost me more in the long run? In the real world, "price" is not just this immediate deal but its ramifications across time and space, and comes from complicated business calculations.

"Marginal cost" has a similar time dimension -- it all depends on how a long a period one is looking at and what costs one must include. The axiom "prices must equal marginal cost" does not tell you whether the relevant time dimension is a decade, a year, or an hour, which makes it into a meaningless statement. So to set up an identity between marginal cost and price, without a tight specification of the assumptions about time, or to assume that short-term marginal cost is the ticket, produces nonsense.

To drive the point home, look at real world examples.

An airliner in Chicago boarding for a trip to San Francisco has some seats empty. Just before the gate closes, a traveler offers the agent $20 to get on. The cost of the extra fuel burned is less than this, and all other costs are, as of that frozen moment in time, fixed, so the airline would indeed make money by taking the deal. But this hardly means that "economics teaches us" that $20 is the correct price in general for the Chicago-San Francisco run. It does not even teach us that the agent should make this one deal, since much depends on calculations of the effect on the overall price structure. Such as, would all passengers then wait at the gate until the last minute, when bargains would be available, and what would this mean for airline pricing and operations?

One can replay analogous scenarios in many other contexts. An automobile assembly line that is running at less than full capacity. A customer entering a stationery store to buy a pen that is priced at $2.00 when it cost about 20 cents to make. Telecommunications services -- the marginal cost of sending a bit around the world a dozen times is close to zero.

In fact, reverse the question. Try to think of an industry in modern America in which marginal cost pricing is workable, in which it would actually promote long-term efficiency. Further, since the dynamic long term is necessarily the sum of the static short-terms, the common distinction between short term "static efficiency" and long-term "dynamic efficiency" does not work either, except under particular limited assumptions wherein the economy is composed of end-of-season or going-out-of-business sales. In the real industrial world, marginal cost is simply the lower bound on price, not the ideal. A company will sometimes sell at this level, but its overall price level must be sufficient to cover every cost, and to conceive of marginal cost pricing as the ideal is demented.

This tension between marginal cost theory and the real world has always caused discomfort. Generations of antitrust lawyers have regarded themselves as the guardians of marginal cost pricing, and view real world departures from it as temporary aberrations in need of correction. This results in blackly humorous interactions between them and businessmen who know, inarticulately, that the standard is impossible to meet, but must pretend to be with the program. They cannot confess that they actually spend all their time scheming how to acquire market power so they will not get caught in the death spiral of marginal cost pricing.

The tension has been tolerable as long as companies could find roads to market power that eluded the technicalities of antitrust doctrine and the attention of a tabloid-ized press. Primarily, heavy investment costs create barriers to entry which, combined with a knowledge of game theory and some conscious parallelism, allow industrial America to function.

But the IP industries have been stripped of this protection. The heavy costs in the pharmaceutical business are in the initial research and the regulatory costs, not is setting up a plant to stamp out pills. The entertainment industry is beleaguered by the new reality that duplicating and transmitting bits takes no capital investment, once the basic computer and telecom networks are in place, so the cost barrier has vanished completely.

Both these industries have been reduced to relying on the protections of the legal system, which means the political system, and that is creating a problem, because the marginal cost mantra has undermined their moral position. People really do feel outraged at the idea of full cost pricing.

It is time for the economists to stop misleading a gullible public. They cannot claim ignorance. Their predecessors of the late 19th and early 20th centuries were skeptical of the Sherman Act and subsequent antitrust laws precisely because of the difficulties of accounting for fixed costs in competitive analysis. Ronald Coase wrote on "The Marginal Cost Controversy" in 1946, in an essay incorporated into The Firm, The Market, and The Law. Professor George Bittlingmayer of Kansas has examined the instabilities in pricing created by fixed costs, using core theory, a concept developed by Professor Lester Telser of the University of Chicago. Holman Jenkins, Wall Street Journal columnist, gets into the issue from time to time.

But in the context of pharmaceuticals and intellectual property, the concern is over the moral impact, not the long-term economics. The current situation, wherein sectors of the economy that are both vital and incredibly productive are systematically delegitimized by moral opprobrium, is not tolerable. It is demonstrating the dark side of Lord Keynes famous

dictum:

[T]he ideas of economists and political philosophers, both when they are

right and when they are wrong, are more powerful than is commonly

understood. . . . . Practical men, who believe themselves to be quite

exempt from any intellectual influences, are usually the slaves of some

defunct economist. Madmen in authority, who hear voices in the air, are

distilling their frenzy from some academic scribbler of a few years

back.

The academic scribblers need to scribble some new ideas.

The author is Senior Fellow & Director, Center for the Study of Digital Property, Progress & Freedom Foundation, Washington, D.C. Mr. DeLong is an attorney. His ideas are his own, and do not necessarily represent those of PFF.

Re: Re:

Re:

First of all, I would suggest that it's not a very good idea for the commenter here to have reposted DeLong's copyrighted content. If we are asked to remove that material, we absolutely will.

However, it does say something that you feel that you can only defend the argument that copyrighted content should be sold by then infringing on someone (in this case, Tech Central Station's) copyright.

But... on to the point DeLong raises. I addressed this directly to DeLong in DC, but his article is just wrong. Not mildly wrong, but flat out wrong -- and it's his inability to understand "zero" that's causing the problem. Let me go through in a bit more detail -- and I'll avoid DeLong's annoying tendency to fall back to insults ("the left" "academia") whenever he hits on a point that he doesn't understand. This has nothing to do with "left" or "right" or "academics" or "professionals." It's an issue of economics, and DeLong's economics are wrong.

"Economics teaches us that in a competitive market prices equal marginal cost -- the extra costs incurred by producing an additional unit." It goes on to note that the marginal cost of an additional pill, or an additional copy of a movie or song, is close to zero. Therefore, the argument concludes triumphantly, "economics teaches us" that such products should be priced at zero. Any other condition demonstrates that undue "market power" exists, and is immoral.

Well, first he adds that little "immoral" bit to the end there, which I've never seen an economist do in this kind of discussion. It biases his argument and takes away from the core, which is true. However, he makes one little shift and it's sneaky. He says "such products should be priced at zero." No, what economics actually says is that "such products WILL be priced at zero."

It's NOT making a moral argument at all. It's making a predictive one. It's saying that the market dictates the price and you can see that overtime the price will equal the marginal cost in a competitive market. That's *how markets work.*

Of course, most markets aren't competitive. The point of this exercise is to understand the pricing pressures as markets do get more competitive. But DeLong flips it around into a moral issue, and pretends that people say that if a market isn't competitive then it's immoral.

If one demurs to the logic, on the ground that it costs about $800 million dollars to produce the first pill, or $100 million to produce the first print of the movie and this initial investment -- not just the marginal cost of the second pill or the second print -- must be recovered from somewhere, the perpetrators of this logic usually shrug and talk about the need for new business models.

Well, first of all, we don't "shrug." We DO point out the new business models. But, again, that's not the point. The point isn't to come up with new business models at all, but to warn those with the existing business models that they're going to be in trouble.

Again, DeLong seems to think that this is somehow a choice, and not an actual force that will impact the business. I really hope that PFF's clients don't listen to him, because they're gonna be in trouble soon.

DeLong then goes on to mock this basic FACT of market behavior because it would mean that you could never recover fixed costs. That's flat out wrong (and really makes you question his economic understanding). The point is that you do look for markets that are not fully competitive or where you do have an advantage of some kind and can charge money and make back your investment. The problem is that the content market is moving away from that. He seems to think you can hold back the tide.

What's funny is that a number of the points DeLong then makes are completely on the mark -- though he falsely tars all economists as beliving things that almost none do (i.e., that most of the market is competitive and that marginal cost *must* equal price).

Again, that's not what anyone is saying. Almost everyone admits that there are very few truly competitive markets and, in fact, that's exactly how profit is made. DeLong is right to note that if the market is fully competitive it's tough to make a profit. That's why companies keep innovating and changing, to get a *fleeting* advantage in which they can charge. But, over time, if they don't change, they get eaten up by the competition.

So it's amusing that DeLong notices this time aspect, but then seems to suggest that the solution is to put up false barriers in terms of IP protection that don't allow the market to advance in this fashion, forcing the innovation he's supposedly such a big fan of.

The problem, of course, is that he doesn't understand zero. He's happy for the progress to continue, but once a zero gets thrown into the equation, he freaks out and says the system (in this case, basic economics) no longer works. That's exactly what he's saying throughout the article and all I'm saying is that the economics does work, and DeLong is blinded by the zero.

What he's missing, due to the zero-blindness, is the fact that the market is for more than just the narrow focused product he's talking about -- but the overall industry. If he looks at how industries can use competitively priced products (commodities) to make other products that have scarcity and have a competitive advantage, he wouldn't be so worried.

Re:

Wow it is quite impressive to say so little in so many words. You are correct when saying there is a lot of mis/dis information out there and you have added to that handsomely. Your lack of understanding of the creative process is staggering. As a musician (semi-professional) and engineer (professional) I have to say what you are saying is utter nonsense. Record companies don't make music, musicians do. The cost of studio time (what we in engineering call Non Reoccurring Engineering (NRE) cost) are quite low these days with the advent of digital studios. If you are a regular reader of this site you would know that Record labels have been caught numerous times cheating the very artist they claim to be representing. It's business, their goal is to make as much money for themselves as possible without going to jail. And when push comes to shove they will risk jail time. The reason for pushing for longer terms for IP is not to create more IP but to make more money off of the IP they've already acquired. If music and visual entertainment would not be created without IP for recordings then there should not have been any before recordings. Obviously there were, I assume you've heard of concerts and plays. Recordings (CDs & DVDs) just make it easier for the non creative types to control the process. The incremental cost for recordings is almost zero as well. Take any concert or play and just record it. The cost of production is covered by those who attend. This argument is complete and utter garbage.

Now for drugs. One only has to look at the profit margins of these companies to know that even if you add the NRE cost they are still gouging, not to mention the impetus to put dangerous drug on the market. It also diverts attention away from other types of solutions. Years ago there I remember reading two articles on a Reuters medical news feed. I found the timing remarkable. The first was the success a Doctor had with heart patients without using medicine. It's what everyone knows, life style changes. It was difficult at first but ultimately it was more effective then medicine. The doc did not have much luck in convincing colleagues. When you have so much money to persuade doctors that all they have to do is give their patients this little expensive pill it's hard for a lower profit but more cost effective solution to get any mind share. The second article was about the constant increase in the cost of health care. Not only is the constant barrage of new drugs expensive it is also not even a very good way to solve the problem. One of the few bright spots is antibiotics. Of course with the constant over use the companies guarantee that they will always have to produce new patented drugs to combat ever more drug resistant strains.

your almost there

Funny how cyclic economic trends seem to be.
I did doctoral research 10 years ago on what happens when marginal costs of goods get's close to zero (in my case, I was studying the cost of distributing the netscape browser).

I came to the same conclusion. as marginal costs gets close to zero, the price will also drive toward zero.

what was missed however, is the premium on end users time - individuals have to deal with the scarcity of time, which forces them to make decisions on which content to spend their time with, or which freeware applications to invest one's time to learn and train on.

what is interesting is as scarcity economics starts to fade, network economics starts to take hold. The very best free products will take the lion's share of users attention, which has tremendous value for different economic models.

The irony of all of this is it isn't new.Traditional broadcast television lived off of a free to user model for decades, and end users were traditionally faced with the limits of their own time as to which show to watch.

Re: your almost there

what was missed however, is the premium on end users time - individuals have to deal with the scarcity of time, which forces them to make decisions on which content to spend their time with, or which freeware applications to invest one's time to learn and train on.

I don't think that's missed, I think that's the whole point (which was part of the point of my next post in this series). You use the non-scarce good to focus on a problem that *IS* scarce: and one very good one is people's time!

That's the opportunity.

The irony of all of this is it isn't new.Traditional broadcast television lived off of a free to user model for decades, and end users were traditionally faced with the limits of their own time as to which show to watch.

Indeed, and it's an important point. None of this is radical. It's just recognizing that it still applies.

I think the disconnect comes from the blind acceptance of the notion that creators ought to control what they create. SHOULD THEY?

Two reasons why:
1. If they don't, then they will have no incentive to produce [this is false. there is, unquestionably, still incentive to produce. art predates economy]
2. why shouldn't they? I control a basket I weave. why not a song? But only a moment's reflection reveals that we intrinsically support your right to command your basket because if someone else does then you are probably left basketless. If anyone should have your basket, it is you. But everyone can have your song without you lacking anything.

A naive person is inclined to ignore these objections and insist that, well, regardless, it is unfair for me to have no say over the ideas I create. I confess such an impulse in myself, but--it is tempered by a solemn realization that there is no mechanism whereby society can guarantee protection over the ideas I create. Nor even can society define the bounds of my idea or the bounds of my control over it. A basket is not an idea.

You can't control the ideas you create, and nobody can help you. We will forgive you if your ideas incite individuals to crime or violence or antisocial behavior. And if you please, forgive us if your words infuse us with passion, awe, and wisdom.. and we are too flawed to recall our decent obligation to reward those who bring us joy. Forgive us especially as our current system has set us up as mutually distrusting antagonists.

I hope I do not presume too much when I absolve you of responsibility for your ideas. I thought this was one of the most brilliant inventions of our civilization. But this road runs both ways.

We subsidize you guys. We create the food you eat and the cars you drive and the power that lights your studio and the tools you use. Whether through the old system of patrons of the arts or the new system of economic activity, we are subsidizing you. You take scarce resources, of which this earth will one day be exhausted, and in return give us mostly fleeting ideas which will almost certainly grow worthless over time as the connection to the environment in which they were created changes and is eventually left behind. Those that are not fleeting are so profound that they are absorbed into our civilization in a way that I will not apologize for. You are repaid thousandfold for these ideas. We subsidize you guys, and I will have this in return.

Yeah, but.

On the surface, I would love to agree with this. In fact, I don't think Mike said one inaccurate thing: marginal cost of reproducing digital media is null. BUT, as Mike admits, the fixed costs still exist. My concern is who pays for those fixed costs? The artist? The movie producer? Sure, I understand that other merchandise -- merchandise that DOES have an associated marginal cost -- can be sold, but this brings up another point:

The cost of producing "other merchandise" is the fixed overhead (land, labor, capital) + marginal cost (labor again, materials). But, as we all know, no one sells items at the same price as production costs, because then there would be no profit and therefore no incentive to produce the item.

Similarly, if one replaces "other merchandise" with digital media, he can conclude that the cost of producing digital media is the fixed overhead (land, labor, capital) + 0. But, as we all know, no one sells items at the same price as productino costs (including digital media), because then there would be no profit and therefore no incentive to produce the digital media.

There are several markets (off the top of my head, drugs) that start with high prices until competitors are introduced -- then prices begin to decline until equilibrium is reached (simple supply and demand). Naturally, companies want to take advantage of the high prices originally so they can equal their investment and then profit from it (otherwise, where's the incentive to produce?).

Idea: What does this mean for the media industry? Well, give it the same laws as patents. If you produce media, you can sell it to earn your investment and profit for X amount of time, then it becomes public domain. At this point, the fixed costs have been accounted for, so it can be sold at marginal cost.

The problem with this idea, even, is that people NEED things like drugs. People do not have the same need for media. People are not going to be as likely to go out and buy the CD or DVD right away (or pay to download), as they have incentive to wait until the cost of purchase is 0.

The only argument I'll accept against this is that people will still go to concerts and to the movie theatre.

Idea 2: If, rather than giving a time limit for the "patent", a profit limit was ordered, people would once again have incentive to wait, knowing (or rather thinking) that prices will drop. Unfortunately, enough people are likely to take this route that the price will not drop. It will become a matter of "how bad do I want it?", which isn't necessarily a bad thing, but there would still be people "mooching" off those who care enough to buy the music.

Re: Yeah, but.

To remove the requirement that consumers of ideas compensate the creators in exchange for their usage in order to recoup fixed costs and thus leave it profitable to create ideas is not to remove all sources of compensation. I think Mike would propose that they find cleverer ways to use and monetize their ideas... I would propose that the creators can still get money from consumers. Most people are somewhat ethical. If we can train them to feel obligated by ethics--though not by nature or law--then artists will get some people's money some of the time.

As to whether that is as much as they should get, or as much as they need, or want, or deserve--I wont speculate. I say only that it is not zero and that as far as nonzero numbers go it is awesomely higher in this civilization here and now than it has ever been at any point in history, as we have a disturbing amount of disposable income to spend on such things.

Re: Yeah, but.

On the surface, I would love to agree with this. In fact, I don't think Mike said one inaccurate thing: marginal cost of reproducing digital media is null. BUT, as Mike admits, the fixed costs still exist. My concern is who pays for those fixed costs?

Whoever benefits from leveraging the free goods into a different market. In other words, whoever embraces the free nature of the content will be able to benefit from it, recognizing that they get promotion for some scarce-good where they have a competitive advantage. Then, for them, it makes sense to pay that fixed costs, because they'll profit from it at the other end.

The problem is that everyone gets so tied up in the idea that you need to sell the content. You don't. You use the content to sell something else (and the list is a long one). And, you could even use the free content to sell the creation of new content. In other words, use the free promotional content already created, to convince people to prepay the fixed cost of creating new content.

This the model some musicians have been experimenting with. They've got enough music that they give away for free to get fans. Then they ask those fans to pay for the creation of a new album. In return, those fans get early access to the new content, or access to the musician in some form or another, or free/cheap concert tix or whatever. And then once the musician has enough money committed to the project he or she creates the new album. And then he can use that content to get more fans and begin the process all over again.

Idea: What does this mean for the media industry? Well, give it the same laws as patents. If you produce media, you can sell it to earn your investment and profit for X amount of time, then it becomes public domain. At this point, the fixed costs have been accounted for, so it can be sold at marginal cost.

Well, technically, that is how it works now.

People are not going to be as likely to go out and buy the CD or DVD right away (or pay to download), as they have incentive to wait until the cost of purchase is 0.

All music is available for free online right now. Yet plenty of people still go out and buy CDs. And there are lots of ways to add additional incentives -- such as including additional content in the liner notes, or letting those who buy the CD get access to a special website or offering tickets to concerts to those who actually buy the CD, etc. etc. etc. Lots of business models.

innovation

One thing to consider is innovation. Perhaps the automotive industry isn't the best example for comparison to online music and DRM, but for prescription drugs it may apply.
In the 1980's Chrysler used parts bin technology to produce 'new' models. Admittedly, the minivan saved the company, but it was a K car (built on a variation of the K car platform). So was the Dodge Aries K, the LeBaron, et al. To see all the variants, go to http://www.allpar.com/eek/k/k.html or http://en.wikipedia.org/wiki/Chrysler_K_platform for lists of the makes, models, and years. These cars cost Chrysler less money to design and build than all-new cars. They were able to grab from the parts bin (need a radio, grab it off the shelf). They undercut prices, offered long warranties (if it broke, replace the part, it costs so little), and used the profits to up the stock and get out of bankrupcy. A drastic measure for bleak times. However, they stuck with that model so long that people drove away (pardon the pun) in droves. The cars were horrible. Lousy parts made lousy cars and there was no money for R&D. That's what can happen when your profits become marginal. Chrysler finallly had to bite the bulit, invest in the future, and make new cars from new parts. Now they are part of Daimler-Chrysler (they sold so little that they became a take-over target), yet even with Mercedes great reputation the word Chrysler leaves a bad taste in some people's mouths. Thus, the Dodge truck has to play catch-up with Ford and Chevy. The lesson is that you must protect your brand's name and that means innovating and producing ever new, quality products. And that takes operating above margin.

Re: Something for nothing

dorpus, there's no way you can be a graduate student... the shit you come up with on here... 0^0 is undefined...

as far as a proof for n^0 = 1 and applying it to 0^0 ... one of the laws of exponents is (n^x)/(n^y) = n^(x-y) for all n, x, y ... so (2^3)/(2^2) = 2^1 = 2 ... but let's look at (2^3)/(2^3) ... this fraction is equal to 1... so 1 = (2^3)/(2^3) = 2^0 ... so 2^0 = 1 ... however 0^2 = 0 ... (0^2)/(0^2) = 0^0 but (0^2)/(0^2) = undefined... so 0^0 power is undefined...

of course, there are plenty of arguments for 0^0 = 1, but these used for special circumstances and need to be defined when in use. the general convention is that it is undefined. there's a reason the rules is any nonzero number to the zero power is one.

Oops

Sorry, didn't realise I needed to use the br tag. Please remove that last one, if possible.
Whoever benefits from leveraging the free goods into a different market. In other words, whoever embraces the free nature of the content will be able to benefit from it, recognizing that they get promotion for some scarce-good where they have a competitive advantage. Then, for them, it makes sense to pay that fixed costs, because they'll profit from it at the other end.

The problem is that everyone gets so tied up in the idea that you need to sell the content. You don't. You use the content to sell something else (and the list is a long one). And, you could even use the free content to sell the creation of new content. In other words, use the free promotional content already created, to convince people to prepay the fixed cost of creating new content.

Maybe I fail to see this long list of something elses that one could sell instead of content. I do, however, applaud the idea of "[using] the free content to sell the creation of new content". This actually makes sense, but the people who invest in the new content are going to want a return on their investment. Which leads to your next suggestion:

In return, those fans get early access to the new content, or access to the musician in some form or another, or free/cheap concert tix or whatever. And then once the musician has enough money committed to the project he or she creates the new album. And then he can use that content to get more fans and begin the process all over again.

Basically, what this translates into is distributing the music for free and making proceeds from concert sales. I like this idea, but it's not always practical. Artists can only do so much touring. They can only reach so many venues and so many cities. This means that certain people (those near the venues) will be funding the artist's content, while those for whom attending a concert is more of a trouble (travel, etc.) than it's worth are receiving the content without contributing to paying for the fixed cost and profit of making the original content.

In addition, it costs money to put on a concert to begin with. If a concert has to fulfill the costs of the concert AND the original content, profits will either decrease (which isn't awful -- entertainers make way too much money anyways, in my opinion), or (more likely) ticket prices will increase, thereby decreasing the number of people who are willing to attend (again, supply and demand).

Well, technically, that is how it works now.

To a degree. The content is still sold for much more than the marginal costs of producing another CD. The problem here (in my opinion) is the presence of the middle man -- record companies. This actually comes back to your point:
- artists do not really need the record companies
- BUT they need sponsorship for advertising
- free content allows fans to hear about the artist without the need of record company advertising.

All music is available for free online right now. Yet plenty of people still go out and buy CDs. And there are lots of ways to add additional incentives -- such as including additional content in the liner notes, or letting those who buy the CD get access to a special website or offering tickets to concerts to those who actually buy the CD, etc. etc. etc. Lots of business models.

Yes. This is true. But many people are hesitant to download music for free due to current legislation. Not everyone, but those who "still go out and buy CDs".

That said, I like the idea of additional, exclusive content, but I have a feeling it would not take long for people to get around these blocks too. Again, there's the discrimination of who pays, but this time in a good way: true fans who love the band and love the music will pay for the extra content, while those who are only experimenting with a new band or new sound will not be paying for something they may not like.

You definitely present many good ideas to support free content, but I feel too many people in the music industry will be too closed-minded to accept some of these business models. Not to mention current contracts with record companies, which would have to expire before the artists could take your path.

Re: Oops

Basically, what this translates into is distributing the music for free and making proceeds from concert sales. I like this idea, but it's not always practical. Artists can only do so much touring. They can only reach so many venues and so many cities. This means that certain people (those near the venues) will be funding the artist's content, while those for whom attending a concert is more of a trouble (travel, etc.) than it's worth are receiving the content without contributing to paying for the fixed cost and profit of making the original content.

No, not quite (and I apologize if I implied that it was only about concerts). I did give that as *one* example, but not necessarily the only one.

However, the argument that bands might not want to tour isn't particularly relevant to the discussion. Some people don't like to work... and they don't get paid. :)

Already, the way the music industry works with things like advance money is that most musicians make their content from touring, not from album sales -- so to say relying only on concerts won't work is untrue. It's already how most bands make their money -- and if they do it our way, they could make even more money by having more fans who want to see them in concert.

But, again, the point is that concerts aren't the only thing in play here. It could be just "access" to the band. What if you got people to pay $20/year to be in a special fan club, that could occassionally talk with or meet the musicians in person, as well as other fans. That's not selling concerts.

What if the music is good enough that a big name brand (Pepsi?) commissions a song for their latest commercial?

What if you add incentives to get people to buy the CDs (physical media), such as having the CD set so that it allows you to access a special user group/fan forum?

These are just a few quick ideas, and there are hundreds more that people can think of. The trick is not to think of it only within the bounds of what's done today, but what can be done when the music is free. Also, recognize that once the music itself is free, you can focus on promoting that, and using that to get many more fans than you currently have. So even if you do rely on concerts, if you're good, they could be much larger venues where you can get more money.

You definitely present many good ideas to support free content, but I feel too many people in the music industry will be too closed-minded to accept some of these business models. Not to mention current contracts with record companies, which would have to expire before the artists could take your path.

Indeed, it will take time. I don't expect this to happen overnight at all. But, what will happen is that some will embrace this, and it will start to spread... and then those that don't will be forced to move in that direction as well.

Re: Re: Oops

An example of a musician who gets the idea of incentives is Jason Webley. His website has free streaming versions of songs off all his older albums, and so I guess he makes his money off concert sales and merchandise. He sells his self-produced albums for $10 - a price that seems pretty fair - and he does things like make limited copies of vinyl EPs.
Of course, the streaming music is Real Audio, which sucks pretty hard, but no one is perfect.

I think people assume that the the real price is always the same or extremely close to the marginal cost but this is not the case. when something first comes out there is a premium to recoup the investment. after that the price tends to gravitate to the marginal cost. firms also use discrimanatory priceing to make back the investment costs.

Re: Re: Oops

I would be intrigued to see someone try this, as it seems to have potential. Again, as you point out, it will take time to spread.

It'd be interesting to see how other parts of the entertainment industry could adapt as well.

I can't think of any more arguments in the "devil's advocate" category, except for objections raised in vain by the record companies. The only thing that I anticipate being a problem in the long term is government.

and still, techdirt ignores the critical issue

I agree that debates about property rights in the digital age are often distracted by faulty thinking about scarcity. So let’s get the facts straight.

Unless a resource is scarce, assigning property rights to those who “produce” that resource is neither sensible nor harmful. After all, even if those who produce an "abundant" resource can exclude others from the portion of the abundant resource that they produce, the value of that right to exclude will be $0 absent scarcity.

But, as economists have long known, scarcity comes in two forms, ex ante, and ex post. Ex post scarcity means that a resource remains scarce even after it is produced and disseminated. Apples, wheat, and iPods exhibit ex post scarcity. Ex ante scarcity means that the resource is scarce until a means to produce and disseminate it is devised. Lighthouses and information goods (like innovations and expressive works) are examples of resources affected by ex ante scarcity.

Copyright and patent law respond to the problem of ex ante scarcity. Anyone who argues that information goods like innovations or expressive works are not "scarce" can validate their argument by producing the following:

-- copies of the films that will win Oscars in 2009,
-- a detailed description of a 100% effective cure for cancer, and
-- a detailed description of a cheap, nonperishable malaria vaccine.

In short, useful information is scarce, and it is expensive to create and produce, until the information in question is created and broadly disseminated.

So the problem with information goods is twofold. First, we must convince someone to incur the expenses and risks involved in creating them. Second, we must convince those who create valuable information goods that they should disseminate them broadly instead of carefully restricting access to those who are willing to pay (a lot) to obtain access.

An example may make this point more clearly. Dr. Stephen Covey studied business practices for many years and concluded that he could identify seven principles that would increase the odds that a businessperson would succeed. For years, he profited from this information by acting as a consultant to Fortune 500 corporations and disclosing it only to the senior executives of corporations that paid his (very high) consulting fee.

Then, copyright laws convinced Covey that he could better exploit his hard-earned insights by publishing a book and making his insights available to anyone willing to pay $7 or visit a library. As a result, The Seven Principles of Highly Effective People was created and widely disseminated. Saying that this particular work is no longer “scarce” because it has been created and widely disseminated dodges the real question: How do we encourage people like Covey to create information goods and broadly disseminate them?

For now, the best answer yet conceived to this question is “copyright”: We give authors like Covey an exclusive right to their expression of ideas so long as they are willing to allow the ideas expressed to pass immediately into the public domain. This bargain explains why you owe Covey nothing if you read a copy of his book at the library for free and then use his seven principles to build a multi-billion dollar business.

To oversimplify somewhat, copyrights are justified by the difference between the costs of creating an expressive work and the costs of copying an expressive work that has already been created, disseminated and become popular. The “abundance” of digital works that have been created and disseminated does not eliminate this justification. To the contrary, it strengthens it: As the marginal cost of reproducing a popular, disseminated work decreases, the justification for copyright increases.

So I agree: If humans already knew everything worth knowing and had already expressed everything worth saying, then it would make no sense to prevent zero-marginal-cost copying of innovations and works that had already been created and broadly disseminated.

But we don’t. That is why copyright and patent laws continue to make sense. And that is why people who support those laws do understand “scarcity” in the digital age.

Re: and still, techdirt ignores the critical issue

I agree that debates about property rights in the digital age are often distracted by faulty thinking about scarcity. So let’s get the facts straight.

Hmm. Tom, you accuse us of ignoring critical issues, but every single issue in your comment I've addressed in the other comments above it.

You claim that uncreated content is scarce. I agree. I never indicated otherwise.

In fact, that's part of the point, as I say above. You use the created content (the non-scarce item) to help sell the creation of new content (the scarce item).

The only thing I'm talking about is once content is created. At that point it is no longer scarce.

Your argument, basically, is that the market can't handle items once they are scarce -- which is why you need incentives to make people create them. I believe that the market works, and that the market is the incentive to create new content goods.

I guess I don't really get the rest of your post, because I've discussed lots of different ways to incent people to create new content without relying on copyright. So all of your points about how copyright is the only way to incent people is, frankly, wrong. It is one way, but it's not a particularly good one, because it's based on introducing an inefficiency in the market.

You seem to be saying that people do understand scarcity in digital media, and to support it you use an example that suggests you don't understand it at all. I'll try to address this further in a later post on this issue, but simply repeating the way things were done in the past isn't proof that the old way makes sense -- or that it will continue to make sense going forward.

Back at it?

Mike said: "If their marginal costs are zero (as is the case with digital goods and intellectual property), then it says that price will get pushed towards zero."

I read this statement to mean that all my knowledge and experience is worthless.

"You can have as much content as you need -- and in that world, it makes perfect sense that there's no costs, because without scarcity there need not be a cost."

This confirms it. Who doesn't know something that isn't valuable in some context?

It's really late and I didn't read all the posts but I'm afraid that whether we're talking music, art, ideas or toys, somebody spent some time creating it, documenting it somehow and in my mind, the idea of that being worth zero is insulting. Regarless of how much money was spent on research and development, how much it costs to make the next one or whether it be an on-going manufacturer of widgets, there is always a cost (fixed, marginal, ethereal or otherwise) and I don't feel that recovering costs or selling at the marginal cost should make any difference. It has to be recovered or it is worthless.

Mike: since I'm an abstract thinker and I'm not getting your concept, maybe you could find some other way/person or drawing to explain it? Maybe I'm not comprehending what you're saying because I count on things to remain the same, so that I can make a buck? Could it be that simple?

Anoymous Coward: Although I enjoyed the passage, perhaps you could have put it in your own words, which are normally eloquent, or gone for the Reader's Digest Condensed Version?

Re: Back at it?

I read this statement to mean that all my knowledge and experience is worthless.

Oh, hell, no. The exact opposite. Your knowledge and experience is extremely valuable. It's just a question of how you can monetize it. Think of it in the Jeffersonian way:

If nature has made any one thing less susceptible than all others of exclusive property, it is the action of the thinking power called an idea, which an individual may exclusively possess as long as he keeps it to himself; but the moment it is divulged, it forces itself into the possession of every one, and the receiver cannot dispossess himself of it. Its peculiar character, too, is that no one possesses the less, because every other possesses the whole of it. He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me.

That ideas should freely spread from one to another over the globe, for the moral and mutual instruction of man, and improvement of his condition, seems to have been peculiarly and benevolently designed by nature, when she made them, like fire, expansible over all space, without lessening their density in any point, and like the air in which we breathe, move, and have our physical being, incapable of confinement or exclusive appropriation. Inventions then cannot, in nature, be a subject of property.

The point is that ideas, once out there, are non-scarce and you can't just charge for the idea. But, the experience applied to a new situation *is* absolutely scarce. So the fact that your knowledge and wisdom that's publicly available gets people to know that you're an expert in an area, should open up lots of opportunities for you to use that knowledge and wisdom and apply it to new situations. That's where the value is.

This confirms it. Who doesn't know something that isn't valuable in some context?

It's not about value. It's about what the economics say the market will bear. Recognize that price and value are often quite independent.

It's really late and I didn't read all the posts but I'm afraid that whether we're talking music, art, ideas or toys, somebody spent some time creating it, documenting it somehow and in my mind, the idea of that being worth zero is insulting.

Again, it's not worth zero at all. But that's how it will be priced. Think of it this way: the commercial you saw on TV today was "free." Was it *worth* nothing? No, it cost plenty to produce and it has value in that it helps drive sales. But they give it away for free, because of that value.

Re: Re: Back at it?

The commercial was NOT "given away for free". The company whose product is being advertised PAID for that ad space (and you'll hear about the high prices paid for a 30 second advertisement during the Super Bowl as case in point). No one gives anything "away for free" under ANY circumstances UNLESS that company expects you to PURCHASE more of that product, service, etc. upon receiving a "free sample". (Of course, if few people actually purchase it after the free sample, such lack of sales may lead to said company's bankruptcy.) Remember that "value" (in this case, being the measure of an intangible asset), can NEVER be recorded 'properly' on a balance sheet -- it can only be estimated (in such things as "goodwill", for example). So the whole argument about "value" is amorphous at best and totally wrong at worst.

Re: Back at it?

I read this statement to mean that all my knowledge and experience is worthless.

Maybe it is. That would depend largely upon your knowledge and experience, wouldn't it? Also, I've noticed that many people tend to overvalue their own knowledge and fail to acknowledge how much of it was actually built upon the knowledge of others. I can't remember the last time I saw a completely original idea (i.e. one didn't depend at least in part from previous knowledge).

Who doesn't know something that isn't valuable in some context?

In the context of artificial scarcity, almost anything cam be made valuable. For example, I have an idea for something I call "breathing". How valuable is the idea of breathing? Not very, because lots of other people have the same idea. But, if I could get a patent on the idea of breathing, then I could create a scarcity of this idea and become quite wealthy licensing it. It all depends on the context. Sure beats working.

It's really late and I didn't read all the posts but I'm afraid that whether we're talking music, art, ideas or toys, somebody spent some time creating it, documenting it somehow and in my mind, the idea of that being worth zero is insulting.

Just because someone invests in something, that does not automatically make it valuable. Whether it insults you or no makes no difference. The world does not automatically owe you a profit on everything you do.

I don't feel that recovering costs or selling at the marginal cost should make any difference.

What place do your feelings have in economics?

It has to be recovered or it is worthless.

How about this: An idea has to "practiced" or it is worthless. If I am a carpenter and know how to build houses, should I receive checks in the mail just for knowing that or should I have to actually go out and practice that knowledge in order to be paid? Or, if I have a dream of something, should I be well paid for the rest of life for that? (The tune for "Yesterday" came to Paul McCartney in a dream.)

Well, it's time for me to go to sleep and do some intellectual work now.

"If Mike was right then there would have been a "free" Internet based music industry by now and there isn't. "

Go to YouTube and do a search on Terra Naomi. She started from no name recognition at all, no record deal, nothing but a pretty face, nice voice, and some songs that she had written. Then she started posting homemade videos of herself singing on YouTube, and built up a fan base. After a few hundred thousand people had watched her videos, she started producing her own CDs, selling them through her website. She used the free distribution of YouTube to create a customer base to sell her much higher-quality recordings.

"Maybe I fail to see this long list of something elses that one could sell instead of content."

If you've ever seen the Flash animation Napster Bad, which parodies the Senate testimony of Metallica drummer Lars Ulrich, you can see a similar theme. Metallica didn't make their money from album sales or concert tickets. They made their money from $3 T-shirts with the Metallica logo, sold for $40. Also baseball caps, lighters, keychains, etc, etc, etc.

PhotoshopX

But, you're right that fixed costs matter very much in making the build/don't build decision. Which is where I fall back to the point that before an investment is made, the product is scarce and can be sold. In other words, you can convince someone (or a group of people) to pay for the fixed cost, if there's enough benefit for them to have the product made.

Fine. I'm a developer and I'm going to build PhotoshopX, which will blow Photoshop out of the water. I hope you and your readers will send me and my team of 50 people enough money to live on for three years. I promise that the end-result will be great.

Ah, I don't see any money yet.

Okay, I'm a director and have made a "B" movie or two. Please give me enough money for me and about 10,000 people to live on for the next ten years. I want to make a movie about some elves and dwarves and such, and promise that by the time it's over everything will be great...

Anyone???

Sorry, but it's not going to fly. Tens of thousands of people are simply NOT going to give you money up front and that far in advance for a pig in a poke. And you NEED that money up front, otherwise you can't afford to spend the time and buy the resources needed to do the project. Kids have to eat and all that.

Now, you might be able to convince a smaller group of people (let's call them, say, oh, investors) that you can deliver something worthwhile. But why will they give you money, when once it's produced everyone expects to get it for free? How are they going to get their money back? Why wouldn't they just put their money in T-Bills? (And, BTW, investment capital is "scarce" too.)

If PhotoshopX is great, simple, powerful, easy to use, and does what everyone wants, then who's going to pay for support? Not needed. And how many donations or PX coffee mugs will I need to get or sell to recoup 150-man-years of investment? (And can expect, for that matter?) Why are we switching our medium of exchange from dollars to t-shirts?

There's simply a certain class of project (books, movies, software, games) that requires a long lead time and one or more (or many, many more) creative, highly skilled people to accomplish. And such people are also scarce, and as such usually don't come cheap.

You continually focus on distribution costs, which even in the material world are often marginal (I can make a boatload of DVDs of a $40M movie for $1M), and continue to ignore that $40M figure on the other side of the equation, which in many cases is the BULK of the costs, and which is the primary amount that needs to be recouped.

So in the digital world I saved $1M in distribution and production costs. Great! Now, let's talk about that $40M.

Oh, and now you're going to tell me about new production techniques and innovations and cheap actors. Okay, fine. Now, let's talk about that $20M...

Re: PhotoshopX

Fine. I'm a developer and I'm going to build PhotoshopX, which will blow Photoshop out of the water. I hope you and your readers will send me and my team of 50 people enough money to live on for three years. I promise that the end-result will be great.

Ah, I don't see any money yet.

Ah, that's because you did a piss poor job coming up with a business plan or marketing your idea. I'm not sure why you think that in this model people HAVE to pay you if you have a bad idea.

Sorry, but it's not going to fly. Tens of thousands of people are simply NOT going to give you money up front and that far in advance for a pig in a poke. And you NEED that money up front, otherwise you can't afford to spend the time and buy the resources needed to do the project. Kids have to eat and all that.

No, you don't need the money upfront. People produce tons of content every day without any money upfront. Why make assumptions like that that aren't true?

Yes, kids have to eat, but if content producers continue to deny the trends, then they won't be making any money anyway and their kids won't eat. The whole point of this is to make sure they can.

But why will they give you money, when once it's produced everyone expects to get it for free?

Is it just me or have I explained this about a thousand times? YOU DON'T JUST SELL THAT PRODUCT! You use it to sell something else that is scarce. I'm beginning to sound like a broken record, but I'm not sure why people keep ignoring that point.

Music before recordings

Let me just get on the record speaking for all the professional, sincere musicians out there:

Music will be made in perpetuity regardless of the price of a CD or mp3. Geniuses who were irresistably attracted to creating music did what they had to do long before Edison.

The ONLY people who think that recorded music getting pushed towards "zero" [aka "free"] is destroying our art are the record labels who are in the business of selling recorded music TO THE EXCLUSION of anything else.

Are you so sure?

Sorry, but I don't have the time to read all of this excellent discussion, so maybe what I'm about to say has been said before.
- Who said the reproduction cost is null? We all paid for our computers and our connections, and we keep on paying for all that. Bandwith is not free.
So the idea that ISP's or computer manufacturers should pay for the contents that help them sell their product might make some sense (as in the Microsoft/Universal deal, maybe).
- Does the economic theory say that the prices should tend to equal marginal costs, or that they will eventually? It is not the same thing. If prices must equal marginal costs in the long run, then the question is "why don't they?", and the answer, regarding the music business, is probably the fact that what we have is really small monopolies of non-substitutable products. If EMI has a monopoly on the Stones' album "Satanic Majesties", they can fix the price however they want to, and I don't want to buy another cheaper album instead.
If there was a competition, ie. if two record companies had the right to sell this album, then the price would probably fall to a certain level, and then, since the real market price would be known, it would probably be easier for everyone to deal with the effects of recent technologies on distribution.

PhotoshopXXX

"Is it just me or have I explained this about a thousand times? YOU DON'T JUST SELL THAT PRODUCT! You use it to sell something else that is scarce. I'm beginning to sound like a broken record, but I'm not sure why people keep ignoring that point."

Mike: your point makes the assumption that people actually want to work for a living. We all know that's not the prevailing "American Dream". You've railed against it constantly, but *the big payout* is what drives a lot of people. The "pet rock" or "Jump...to Conclusions" business model, so to speak, seems to be a major driving force, as you often, astutely point out.

In your world, if people do something fantastic, they still actually have to *work* for a living! While I agree with your world-view, I thinkthis is the crux of the misunderstanding in the thread above. You could repeat yourself til you're blue in the face -- nobody seems to want to hear that.

nothing is free

hat tip: Walter Williams PhD George Mason University, Distinguished Professor of Economics:
http://www.townhall.com/columnists/WalterEWilliams/2006/11/08/common_sense_economics
The second element is there's nothing that's free. Politicians talk about "free education," "free medicine" or "free housing," but that's nonsense. Resources are required to produce each of them. Of course, some people received these goods at a zero price, but that doesn't mean they didn't cost someone, usually a taxpayer, something.
So, to quote the good doctor, nothing is free - not even "free" digital goods.

Ideas built on sand

Two economists are walking down the street when one sees a $10 lying in the gutter. "Hey look", says the first economist, "there's a $10 bill on the ground". "It can't be", says the other, "somebody would have picked it up by now"

Economics is not "econology" because it is not a science. Never was and never will be. It fails the test of hard science and fails the test of human sciences, falling into a grey area as a self serving set of circularly defined observational theories.

Many of the reasons why the world is in such a terrible state can be directly attributed to the folly of taking economics seriously and allowing important decisions to be based on economics.

Just like a world without zero and a world that everybody believes is flat the illusion is so deeply entrenched in thinking that it could take hundred years before we are able to shake loose this disabling peversion of social theory. The same goes for concepts like money and intellectual property. We are victims of our own twisted and baseless concepts because we lack imagination.

Re: Ideas built on sand

Your very thought experiment could fuel some insightful economic reasoning.

Economics has two main parts: identifying how people behave and what the consequences are; and trying to use this knowlege to find ways to improve our well-being.

The importance of the first part should not be underestimated. It is basically like simple algebra for human interaction. A civilization where everyone is able to think economically is flat out better than one otherwise because it provides a system for reasoning in a domain which is otherwise bereft of any structure or sense.

That the second part, guessing how to use this knowlege, has resulted in enormous governmental mis-steps is unfortunate. But this only underscores the sheer power inherent in the discipline--leaders are attracted to the light, and we all get burned. Just because nobody has yet proven able to fully wield the power does not mean that nobody ever will.

scarcity and abundance

abundance is NOT the opposite of scarcity.

A thing is scarce if there is less available than consumers want. Beach sand is not scarce yet is abundant. However, AIDS infected blood samples are neigher abundant nor scarce (yecch, who would want it?).

Likewise, free digital stuff is not unlimited as the internet pipes (ha ha silly senator) have finite bandwidth, user accounts have finite download limits, users have finite attention and patience the internet infrastructure is maintained by and billed to someone.

Also, the usefullness of something that is its value is often decreased when there are copies made. Money is a good example. Make a perfect copy of money as North Korea learned its worse than detonating a nuke.

A zero cost promotional good?

"One simple example of this is to use that item that "costs" zero as a promotional good for something that does not have a zero marginal cost."

If something has no cost then it has no value. Think of something that people would truly pay nothing for because it is ubiquitous, like the air we breath every day, which is impure but adequate, or the "right to make a left turn when we enter a forest". These things cannot be used as promotional goods precisely because they have no marginal value.

When you propose that something can be given away as a promotional item it assumes that someone somewhere would perceive gaining a marginal benefit from its acquisition. This means that your choice of item does, in fact, have a value and therefore a cost, and is therefore disqualified from consideration as being in the 'zero' category.

Re: A zero cost promotional good?

Umm, David, please consider the difference between the concepts of COST and VALUE.
You can have a gold Rolex that COSTS a lot but has little to no VALUE for a lot of people or you can have a drawing by a 4-year old kid that has almost no COST associated with it but tremendous VALUE to the parent.
Value does not correspond to cost, market forces (people's needs/wants) decide the value of an object, while the material/labor/time define costs.

Mike you are wrong on Italy and pharma

Mike:

Italy had a strong pharma industry pre-patent for the same reason China has a strong DVD manufacturing industry today.

Sales were strong because they copied, manufacturered, and often exported products discovered (and patented) by others. Thats why there were so many small pharma companies in existance, most with minimal R&D budgets. When the no-patent advantage disappeared Italy as a high-cost state had no advantage anymore. Hence, the decline both in sales and companies. Companies that couldn't innovate, died.

The remaining companies that had actual R&D teams did very well in the late 80's and beyond. Check out the patent application trend in the 1980's for Italian pharma - it really rebounded starting in 1986.

Zero costs not entirely true

There are some costs involved with digital content for example the media it is provided on or the storage it is saved on, the bandwidth used to download it, the equipment used to copy it. Now that said some of that will become zero with sufficient volume (for example bandwidth if paid for as a monthly fixed cost, the equipment for copying would be fixed), but storage space or DVD/CD/flash media does have a cost that doesnt diminish because its based on the size of the content.

This article certainly sparked some serious feedback and a bit of controversy. I'll leave the economical side of this alone as I havn't been in a statistics or eco class yet.

However, just one sentece you mentioned sent a twinge of annoyance up my spine.

"Zero caused all sorts of problems in that it didn't work like other numbers. It isn't a number. It's the absence of a number, and that screws up a lot of things."

Zero is a number, it is an integer with the value of zero. That may sound redundant but all numbers work in this way; take one for instance, you can set a teddy bear down on the table and point to it and say "one". That teddy bear does have the property of "quantity: one". But the teddy bear isn't the number one, it just has a value of one. Zero is similar, it is just as easy (if not easier) to set zero teddy bears down on the table, point to it and say "zero". The reason most people don't recognize zero as a number with a defined value is that it goes against what they think is logical. We just see zero as an abscence of number because it's taught to us that zero teddy bears don't matter; they have no real-world value.

A good example of zero's social stigma is counting. No one starts counting "zero, one, two". They start with "one, two, three". Unless, of course you're a mathematician or programmer, you start counting with one. It's just not taught to us that zero is a number that needs as much love as all the others.

The same could be said for counting in the negatives. If you were to start at -1, and go backwards you would count "-1, -2, -3". But you would happen to notice the zero sitting right before the -1 in your mind's eye. It's only second nature to recognize zero when we count backwards.

Good article, Mike, and I read that book as well. Charles Seife is the author and his writing makes me happy. He's who got me interested in theoretical mathematics.

The price will only move toward the marginal cost if the manufacturer/copyright owner/whoever lets it – specifically, if they do not control the price. Most successful producers control their price.

A great example is the iPod -- the price is controlled. Apple operates highly controlled reseller channels and religiously enforces minimum advertised price rules. There's initial scarcity when a new unit is released but still the price is well maintained and controlled after initial demand has been quenched and the scarcity is gone. And the market supports that price.

In the proposed model (or the impending proposed model), it is seems that it is being suggested that copyright owners piggy-back where possible on advertisers. Or more precisely, piggy-back on those who control price and a sense of scarcity of separate higher margin products.

Automatically, this creates a huge problem -- the content creator now has to design their work to be palatable to advertisers. For the most popular and most innovative creative works, that simply fails -- it fails society and the artist. How does a Henry Miller or even a Nirvana sustain themselves when their work is obviously important to the public but not a great vehicle for advertising or 3rd party brand development?

The copyright owner is as entitled as the maker of MP3 players or the makers of soap to control their pricing and to control their product, to restrict distribution, to price above zero. Therein lies the key to free markets – the creator should be free to do what they want with their product in terms of their go to market strategy.

DRM systems provide one mechanism for exerting creator control with digital goods. DRMs are in their nascent stages -- lacking in the requisitive sophistication at this point. But a powerful DRM is a good thing for digital product makers who wish to use it.

I agree that it is neither necessary nor fruitful for the US government to be involved in enforcing DRM. But I think basic business history shows us that poorly controlled products nosedive toward marginal cost whereas well managed products serve their creators very well financially. That free (ad-supported) TV is losing viewers (and premium ad dollars) to subscription based TV models is one illustration of this -- the TV guys have figured out that free ultimately means a poor product and an unhappy customer.

Going back to the earlier example of the iPod actually provides us with a stellar example of where the proposed model has failed to deliver for digital content creators/providers -- Apple's, as the the 3rd party business leveraging the digital assets of others, has and will always push the cost of those digital assets to their marginal cost in order to sustain the perceived value of the (strategically more important to Apple) digital music players. Hence, a song is an arbitrary $0.99 (a price dictated by Apple) and the iPod is $349 (a price dictated by Apple). That's a problem for content creators -- when someone else prices your product, you are going to be screwed by them when it's in their interest to mark down your product to its marginal cost.

Business will continue to be cruel to digital content creators unless they better control their product.

The price will only move toward the marginal cost if the manufacturer/copyright owner/whoever lets it – specifically, if they do not control the price. Most successful producers control their price.

A great example is the iPod -- the price is controlled. Apple operates highly controlled reseller channels and religiously enforces minimum advertised price rules. There's initial scarcity when a new unit is released but still the price is well maintained and controlled after initial demand has been quenched and the scarcity is gone. And the market supports that price.

In the proposed model (or the impending proposed model), it is seems that it is being suggested that copyright owners piggy-back where possible on advertisers. Or more precisely, piggy-back on those who control price and a sense of scarcity of separate higher margin products.

Automatically, this creates a huge problem -- the content creator now has to design their work to be palatable to advertisers. For the most popular and most innovative creative works, that simply fails -- it fails society and the artist. How does a Henry Miller or even a Nirvana sustain themselves when their work is obviously important to the public but not a great vehicle for advertising or 3rd party brand development?

The copyright owner is as entitled as the maker of MP3 players or the makers of soap to control their pricing and to control their product, to restrict distribution, to price above zero. Therein lies the key to free markets – the creator should be free to do what they want with their product in terms of their go to market strategy.

DRM systems provide one mechanism for exerting creator control with digital goods. DRMs are in their nascent stages -- lacking in the requisitive sophistication at this point. But a powerful DRM is a good thing for digital product makers who wish to use it.

I agree that it is neither necessary nor fruitful for the US government to be involved in enforcing DRM. But I think basic business history shows us that poorly controlled products nosedive toward marginal cost whereas well managed products serve their creators very well financially. That free (ad-supported) TV is losing viewers (and premium ad dollars) to subscription based TV models is one illustration of this -- the TV guys have figured out that free ultimately means a poor product and an unhappy customer.

Going back to the earlier example of the iPod actually provides us with a stellar example of where the proposed model has failed to deliver for digital content creators/providers -- Apple's, as the the 3rd party business leveraging the digital assets of others, has and will always push the cost of those digital assets to their marginal cost in order to sustain the perceived value of the (strategically more important to Apple) digital music players. Hence, a song is an arbitrary $0.99 (a price dictated by Apple) and the iPod is $349 (a price dictated by Apple). That's a problem for content creators -- when someone else prices your product, you are going to be screwed by them when it's in their interest to mark down your product to its marginal cost.

Business will continue to be cruel to digital content creators unless they better control their product.

The fallacy of zero

If you ignore expenses, the marginal cost of everything is zero. So everything should be free. Yeah! Let's sell everything for free. What we lose on individual sales we'll make up in volume. Not.

Now let's get realistic. Say it costs me $10,000 to produce a record. The cost of the first CD is $10,000 and all others are $1. So what I should do is wait until someone comes along willing to pay $10,000 for that first one so I can recover the cost and then sell subsequent ones for $1. That sounds like a great business model.

Let's try again. I'll sell all the records for $1. How do I recover the $9,999 in initial expenses? I'll do concerts. Yeah, that's the ticket. It costs me $1000 to rent the hall and I can fit 100 fans. Of course, my competition which only does concerts just charges the fans the marginal cost of the concert, so I have to do that to stay competitive. So I have charge $10 a ticket. Hmm, not only is that not a way to recover my costs, I'm working harder and still not making any money.

Maybe I'll sell the CDs for $1 and make the CD expire so you have to buy a new copy from me after 30 days. That won't work either. I sell more CDs but I still never recover my initial investment.

How about I sell accessories that enhance the value of the CD? But I can't price them above my marginal cost (zero again) so that's not a good way to make money either. Selling service plans to help you open that annoying CD packaging won't work either.

There is a system that works. Amortize the cost of the so-called fixed expenses. Say I buy a CD burner. It has an expected lifetime. It can burn a million CDs before it needs to be replaced. Divide the cost of the burner by one million and that's the cost per CD. If you divide by infinity, you get zero. But infinity is a fiction in this context. Not only is there no infinite supply of anything, there's no infinite demand.

There's one other thing wrong with the arguments. IP is not a commodity market. Not all CDs are equal. I'll leave that analysis for someone else.

Re-read your economic theory

Your post fails in a very fundamental way and it is that models have a set of conditions that must hold before applying the model.

The *hypothesis* (and not fact, as you pretend) that market drives prices to marginal cost is only based on the assumption that, given enough competitors for *the same* good, and given enough time, they will optimize their process until the price matches the marginal cost, or will be driven out of business by someone who does. This can be applied to generic lightblubs, because If I it costs me $1 to make a lightblub and I choose to sell it for $2, someone else can choose to sell it for $1.5 to gain market share and so forth, ultimately driving the cost to slightly above $1.

There are many many examples of situations where this model doesn't work because the two conditions are not fulfilled. How came a McDonalds isn't sold at the marginal cost? Or a Starbucks coffee? An Apple computer? Yes, because these are brands, which are as aethereal as content - they are Intellectual Property. A hamburger is a hamburger, but there is only one McDonalds hamburger and no one else can make a hamburger and say it is a McDonalds hamburger. And there are many other factors to consider, even if we put aside the IP issues : For example, why microprocessors (regardless of brand) aren't sold at margin cost prices? why aren't airplanes sold at margin-cost prices? why aren't stamps sold at margin-cost prices? There are many many factors to consider before applying the margin cost hypothesis, which is far from the universal truth you pretend it to be

The fact that you can get something at zero cost doesn't mean that you can retrofit that fact as a non-sequitor proof of some hypothesis. I can stop by an orchard and pick a couple of oranges for free. I'm breaking the law, of course, but nobody is looking and it's too difficult to track, so it's dubious that I'm going to be punished. But all of this doesn't imply in any way that the cost of oranges is zero or some market nonsense, it only means that breaking the law in this particular case is very easy.

The same happens with content. It's not that the model is "broken", its just that it's not applicable because nobody else can make MY particular lightblub : If I choose to sell Star Wars for $30 when my marginal cost is $1, noone can make another "Star Wars" and sell it for less (unless, of course, you're advocating dropping intellectual property altogether), so it is NOT true that market *in general* will drive prices to the marginal cost, but only in some very specific circumstances.

Yes, kids have to eat, but if content producers continue to deny the trends, then they won't be making any money anyway and their kids won't eat.

Not true. They won't be making any money AS CONTENT PRODUCERS. They could become plumbers and continue making money. If one chooses to be a content producer it allows him to make a living out of it.

We can apply your own reasoning to see where it gets us: Let's assume that there is really a margin cost of zero, because probably people are going to buy not "Star Wars" but just "a movie". People will look at the DVD bin and pick the cheapest of them, regardless of the title. So what kind of movie am I going to make next time? One that maximizes my profts, of course, and since I can't control profits by setting a price, I will have to reduce my expenses, to the point that they are lower than the ammortized summed difference between the price and the marginal cost. And that is going to be a pretty low figure, believe me. So in the end, we'll get crap (or whatever concent can be produced at a very low cost), assuming that we get anything at all, because If I see that after 1 year effort I'm going to get an infinitesimal profit, I'd probably rethink whether it's worth the effort or it's more profitable to become a gardener or a plumber.

AFAIK if one's business model is successful, it usually produces more output, not less output with time.

How can you then explain that the amount of "free books" posted per year has diminished with time? If they sell more titles when posting free copies online, why aren't ALL their books posted online for free?

It will work

Automatically, this creates a huge problem -- the content creator now has to design their work to be palatable to advertisers. For the most popular and most innovative creative works, that simply fails -- it fails society and the artist.
..............................................................................

No, that is the creators choice now, and then... and even when that is the goal of the creator it does not ensure success. Take the song Back in Black by AC/DC... recently used on a Razor commercial... song was written BEFORE cell phones, and was being used for its recognition value... they paid for use of the song because they made money off of it.

Now lets pursue this Idea a little further... No one is saying AC/DC should just release this and future content for free because that will be the eventual price the market will bear, or release all IP rights associated with it.

Rather I (and I think Mike and others) are saying that AC/DC should release lower quality releases to the public domain, with higher quality releases including additional content for a higher price. Include something they CANNOT get elsewhere, access to the band via club membership, opportunities to select shows... ect...

They will find that greater exposure helps push sales of "Scarcer" content, and generates a greater and friendlier fan base.

As a musician I come back to this topic again and again... but it can apply to a great many products that are digital in nature. Release the prequel or first in a trilogy series and you have fans clamoring for the next release.

And to clear up a point I see many people making an arse of themselves over... and Mike has to repeat himself about...

The point of marginal costs DRIVING price TOWARDS zero has nothing to do with the INITIAL costs... or the costs required to produce INITIAL batches which will be SCARCE and thus subject to that economic theory. Just simply that the EVENTUAL price must reflect the marginal drop in price as availability increases (i.e. SCARCITY DECREASES = COST REDUCTION).

In the digital domain you have an unusual precedent... reproduction costs are ALMOST ZERO. We're not reproducing McBurgers here and having to continually purchase beef and buns to turn out a consumed product that will have to be purchased 3 times a day. Or a Book that my wife can't read while I am reading it. Nor are we talking about a book that once I read it and pass it on to a friend I no longer can reference it.

We are talking about the closest thing to IDEAS that mankind has ever been able to distribute.
...............................................................................
ideas should freely spread from one to another over the globe, for the moral and mutual instruction of man, and improvement of his condition

no one possesses the less, because every other possesses the whole of it. He who receives an idea from me, receives instruction himself without lessening mine
..............................................................................
So AC/DC really loses nothing when their song is "pirated" by an individual user. They wouldn't have purchased it without some exposure, and now a new fan is itching to purchase more of that bands material... and come see them in concert.

Their notoriety has grown with the increase of the fan base and the additional "share" on the internet... while their costs to market and distribute have reduced.

New fan= word of mouth advertising as well as a dedication of electricity, bandwidth and computer resources to share the release in the digital domain.

I see the clouds gathering... I warn the crew doing chalk art on the sidewalk of impending rain... and they lobby the weatherman for a sunny day so they can continue business as usual. Its not that their IP rights are fixing to be violated... just their monopoly on the sidewalk is coming to an end. No argument they can make will negate the fact that it is going to rain.

No argument the IP monopolies make will negate the fact that digital distribution costs have DROPPED. They APPROACH zero... and assuming we're criminals is a dangerous path they take, when embracing the fact will probably set them ahead in their game.

If you have an apple and I have an apple and we exchange these apples then you and I will still each have one apple. But if you have an idea and I have an idea and we exchange these ideas, then each of us will have two ideas.

Scarcity Economics

The delusion of "zero marginal cost" is predicated on the notion - "don't know and don't care".

These folks are simply unable to discern the difference between a natural pearl, a farm-grown pearl and a plastic pearl - nor do they care as long as they pay the cheapest possible price. If you don't know the difference the cheapest is good enough - unlike Oscar Wilde who declared, "The best is good enough!"

Unfortunately natural pearls are rare and dangerous to find. And pearl farmers and plastic pearl makers have steadfastly refused to produce their wares without recompense - regardless the protestations of professors and other assorted ill-behaved children.

The same will be found true for music - in fact listen to the current crop of "artists" and judge for yourself.

Does this necessarily imply no more IP?

Let's say I invent a new thing called a widget, and the marginal cost of widgets is zero. I will eventually be forced to provide widgets to my customers at a price of zero, but that's OK because I'll use this cost-less widget to sell something else that is genuinely scarce.

Won't I still need IP to prevent my competitors from using my widgets to promote their own genuinely scarce thing? I'm not making a moral argument, just an investment one. If record companies are supposed to give away content as part of a better business model that involves selling something else, what value does the content add if they can't exclude their competitors from giving it away as well?

The crux of the point here seems to be that free things are not content you can sell, it can only be leveraged into selling something else or free promos etc. While that business model exists in some cases, there seems to be many where it doesn't or is questionable.
While i do pay for the movie theater experience, I don't "pay" for the DVD physically (maybe like 25 cents). take away the IP and sell me the movie without special features and i'll take that free version over some movie studio's bundle. yes you can add concerts or insider tracks or ties to this and that (new movies coming out whatever) but if that has to compete with a free version, i wonder how many people will choose the value added versions? is there enough value to be added. ditto for music but this is more viable because seeing the artist in person is difficult, so offerings along that line have more intrinsic value (which is of course relative to the individual fans).
Linux is hard to administer and customize, so selling support makes sense, the "free" version has a built in problem to be solved.
but what's the model for pharmacology? buy mine because it has 1-800 support? buy mine and get some other additional medicine? i honestly can't think of any model for this and i bet that's not the only thing.
and the second problem is, still, suppose there were. If the fixed costs for pharma is huge, and then anyone can take that and incorporate it into some other product or bundle, why would some company product that medicine just to have someone else outcompete them by marketing their bundle or added service? the other company can essentially do the same thing for free.
Music has a human motivation, people are creative and will make music for free to express themselves. while some people might love medicine, or have had a family member succumb to a disease and be personally motivated to find a cure at all costs, the barriers to entry and finances required at this point are huge, so direct profit is much more heavily a motivator. Linus Torvalds made linux because he loves it, not to make money. Phizer makes drugs to make money, not for the love of it or to advance mankind. if they can't recover their fixed costs, or if after they develop a medicine and spend all that money they have to compete on even footing with another company that spent $0, why would they ever do it? 2 companies start from the same place, one spent nothing the other is already $800 mil in the hole and has to recover that.

The Number Zero.

I'm economically challenged, but since I was a little girl, I thought of zero as the grandparent of all numbers, the center of infinity.

All negative numbers look to it and all positive numbers flow from it and vice-versa. Originally the Greek letter O represented zero and it also represented Omega.
My thoughts are that if God had a number ascribed, it would be zero, the only perfect number.

My son made me come to this thinking accidently when he asked me about God as young children are prone to doing. I told him God was everywhere and in everything. My son said, "God can't be because I see nothing."

Nothing, zero.
Zero is the connection between opposites, anti-matter and matter; concepts such as yin and yang and in physics as well. I could go on and on, but I won't

I do have a question however. Using the principles of scarcity and allocation, how can we make sense when it comes to insurance? They provide no goods or needed services. They are more of a gambling tool where we bet against ourselves. As a child, we didn't use insurance, yet our products and medical care were much more affordable. Since insurance has become a norm and even mandatory, the cost of goods have drastically increased.

Thanks for exploring my favorite number. When will you look into the number 9?

re: The Number Zero

> Using the principles of scarcity and allocation, how can we make sense when it comes to insurance? They provide no goods or needed services.

Lemme give it a shot. (: Mike says that any content that is not yet created is scarce and therefore you can sell it. Well, when you purchase insurance, when did you get the money you're supposed to receive when you have a claim?

It's easy to see the flaws in this reasoning. There are two fundamental errors it.

First, mathematically there is a difference between a tendency towards the marginal price and the price itself. It's the concept of mathematical limits. The limit value of the price is the marginal price (which might be zero), but that is never reached. So the price will never really be zero.

Second, the fact that demand is ont infinite, is ignored. Yes, the product can technically be copied unlimited without marginal costs, but it is technically impossible to actually copy the product infinitely. So the non-marginal part of the price still has to be paid and thus the total price could never be zero.

Third, the original creator of the product has no control over distribution. So anyone is able to distribute the product without having any kind of ownership. It's quite obvious this practice should not be legal.

'Physical (Real) Property' ≠ 'Intellectual Property'

What Part of 'Physical (Real) Property' ≠ 'Intellectual Property' (i.e. Digital Content) do people not understand? Most of the comments I have seen here that disagree with Mike have missed this point completely.

As Above:
"By George Bernard Shaw
If you have an apple and I have an apple and we exchange these apples then you and I will still each have one apple, But if you have an idea and I have an idea and we exchange these ideas, then each of us will have two ideas."

I'm curious about this...

what about the costs of creating the thing that doesn't have reproduction costs? what about creation costs, and what if that content IS the product, not a loss leader to sell something "non-digital".

the whole idea that all digitally distributable content is a loss leader to sell non-digital goods seems shortsighted.

music, movies, software all loss leaders to sell non-digital goods? I don't know what that world looks like.

"One simple example of this is to use that item that "costs" zero as a promotional good for something that does not have a zero marginal cost. When you realize how zero factors in, you realize that there's nothing new or radical here at all. It's just coming to terms with the idea that free market economics still works in the face of zero (in fact, it thrives) and there's no reason to put in place government-sanctioned barriers to shape the market."

ok I get it.

mikes whole point is no digitally distributable content can ever be sold as a commodity itself. it can only be given away to sell something else (i'm not sure how that works, given that if it's free - and readily available it can't really add value to anything else - I guess all content becomes "advertising" awesome future).

But that's basically his rap.

You can make money making content by being paid to create the content specifically. But once the content is created, it's cost to create can not be recouped without somehow using it to leverage another non-digital product sale.

the fundamental problem with all these NEW business models is that it is exactly like the OLD business models except you remove the revenue from the primary product that was created in the first place, the actual creative content!

star wars was not created as a business to sell action figures, it's nice it worked out that way, but that wasn't what inspired it's creation.

led zeppelin probably weren't thinking about selling t-shirts when they wrote stairway to heaven.

this type of class war on creatives is about as disturbing as it gets.

I wonder if the pirate bay isn't paying mike's bills. Mike - do you really believe this stuff? Stunning...

Re: ok I get it.

the fundamental problem with all these NEW business models is that it is exactly like the OLD business models except you remove the revenue from the primary product that was created in the first place, the actual creative content!

Heh. Except that's not true.

The problem is that you assume a zero-sum game, and that the content creators are selling as much of those other things as they would if the content is given away for free. That's not the case. If you are giving away the content for free, and encouraging it to spread widely, you now have a much larger audience of fans willing to buy the other stuff.

star wars was not created as a business to sell action figures, it's nice it worked out that way, but that wasn't what inspired it's creation.

led zeppelin probably weren't thinking about selling t-shirts when they wrote stairway to heaven.

Of course not. But what's your point?

this type of class war on creatives is about as disturbing as it gets.

Wait, what? Helping content creators embrace economics and make more money is a "class war" and "disturbing"? How?

I wonder if the pirate bay isn't paying mike's bills. Mike - do you really believe this stuff? Stunning...

What?!? None of this has anything to do with piracy. It's from the perspective of the content creator.

And, yes, of course, I believe this stuff, because there's evidence to back it up.

Do you have ANY actual evidence to back up your position other than tossing out random ignorant insults my way?

Content Creators should only sell T-shirts to survive?

I understand the logic, and as a consumer - I fully agree: content that has 0 cost to distribute and is freely done so - awesome!

But as a content creator, an owner of a publishing company - I have to disagree. Why should I invest in the creation of new works (i.e. books), pay advances to authors we bet on - spend thousands of dollars, and then hope to sell maybe a few T-Shirts or 'access' to the author?

There is no definite economic formula to ease my business mind here. It makes no sense to hope for a small percentage of patrons that will both enjoy the books and wish to purchase 'other stuff'.

True, digital books cost nothing to distribute and I'm impatient to see where this industry is going, BUT - the original cost of both the author's time, the editor's time, the InDesign specialist's time, the book cover designer's time, my time and additional overheads (secretary, meetings, fuel, office rent, etc.) - these are overwhelming.

The current cat and mouse chase in the legal areas is annoying and unhealthy to everybody, both consumers and content creators.

Mike, please don't get upset on me as well - I'm not saying you're wrong, I'm saying you've got only half the formula right. Selling 'other' things when you're in the business of creating content is not a valid business model. Yes, some will make it work but only those that get the public awareness for what they're doing...

C.K. was already worldwide popular when he SOLD digital copies of his show. You praised him but didn't ask him to 'give it away' right from the start and sell T-Shirts, right?

He was honest and admitted the COST of production and the PROFITS he has made. You did NOT ask him to suck it up and absorb the cost, because he could distribute it freely online... or did you?

As a consumer - I hope we will all enjoy content freely and guilt-free lawfully and without annoying commercials. Really, I do. I hope to spend less on entertainment and education because of the 0 margin of distributing digital content...

But on the other side of the equation, I still need to feed my family, pay the authors and editors and secretary and myself.

Giving consumers 'reasons to buy' is the job of marketers - and that's who will be the content creators if we continue in this road. In fact, look at what happens in Kindle ebooks right now - marketers are creating low-quality nonsense 'information' books and selling them cheaply... is that our future culture?

Why will they give you money?

I think you might be able to convince a smaller group of people that you can deliver something worthwhile. But why will they give you money, when once it's produced everyone expects to get it for free?

Irrelevant to the real world of copyright and media

This abstract discussion of scarcity and zero and the marginal costs of production is interesting, but it has almost nothing to do with copyright in the digital age.

There may be an infinite (or near enough) supply of tweets about Justin Bieber, but once you consider the kinds of content where copyright is seriously discussed, that doesn't apply any more.

There is not an infinite supply of news or analysis. Somebody has to do work to gather it.

It bugs me that people take these abstract notions of zero and no distribution costs and infinite supply and so on and use them to justify a "content wants to be free" ethic -- which is essentially theft.